Foreign direct investment – a behavioural finance approach

Abstract

The aim of this thesis is to contribute to the understanding of corporate decision making regarding foreign direct investments (FDI) by applying two behavioural finance concepts, home bias and herding, to the analysis of FDI flows. I contribute to the literature by empirically testing for home bias and herding in an FDI context using a very broad panel dataset. I also contribute by examining the country policy implications of home bias on FDI flows between two countries by estimating the probability of an FDI relationship between two countries. In addition, I contribute by providing a generality of the results at a global, regional and country levels. The analysis in this thesis is conducted on a large panel dataset of the FDI inflows and outflows of 30 OECD member countries with their FDI partners, across 25 years in a bilateral country pair format which is a novel application of this dataset for the purpose of studying home bias and herding in FDI.

The findings in this thesis confirm that there is an overall home country bias that is demonstrated through the preference for direct investments in places with greater physical, institutional and cultural proximity to the investor country. These general findings of home bias are observed and confirmed across different data segments: regional and country levels, across time and across different income country groups. I do not find that the effects of home bias have disappeared or diminished across time or at different geographic locations. Herding is another behavioural finance concept which is considered in the context of FDI outflows. Direct investors tend to herd around a perceived world or a regional leader when considering investments in faraway places and when they do not have the familiarity factors in common with an FDI partner country. Finally, by increasing the institutional and cultural familiarity, countries can significantly increase the probability that they will get a direct investment from a country with which they might not otherwise be having an FDI relationship.